Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 12 September 2017

Revolutions in Economic Policy

The Commission on Economic Justice hosted by the Institute for Public Policy Research (IPPR) has just published a substantial and comprehensive report on the UK economy called ‘Time for Change’. I hope to write about aspects of that report later, but its basic premise is that we need a revolution in economic policy making, akin to the revolutions enacted by the post-war Attlee government and Mrs. Thatcher. The thinking behind the idea of economic policy revolutions is outlined by Alfie Stirling and Laurie Laybourne-Langton in a paper in The Political Quarterly.

The authors adapt the ideas of Thomas Kuhn’s The Structure of Scientific Revolutions to economic policy. I do not want to get hung up on the legitimacy or details of this. The basic idea that some periods involve profound changes in economic policy is not really contentious. Also the idea that the ‘failing paradigm’ will first try to adapt itself before being replaced by the revolutionary idea is straightforward. You only need to look at the state of current politics in the UK and US to take seriously the idea that what could be called the neoliberal era - the set of policies and world view associated with Thatcher and Reagan - is coming to an end.

There is a lot in the paper that I agree with, at least until the conclusions. [1] But I think my main critical comment would be that the paper focuses too much on macroeconomics, and as a result goes a little astray. It is if, having borrowed Kuhn’s idea and applied it to economic policy, the authors feel obliged to keep going back to an actual academic discipline, macroeconomic theory, rather than staying with economic policy as a whole. Let me set out first how I see the macroeconomic transformation that took place around the time of Thatcher and Reagan.

A key mistake that many people make is to say that conventional Keynesian macroeconomic theory was unable to explain stagflation, and that policymakers adopted monetarism or new classical ideas as a result. The basis for understanding stagflation and reducing inflation was known since at least Friedman’s famous address in 1968 giving his account of the expectations augmented Phillips curve. This Phillips curve was not used to guide monetary or fiscal policy before the end of the 1970s because most policy makers and some economists were reluctant to raise unemployment as a way of reducing inflation. [2]

In the UK this use of demand management to control inflation (or its counterpart, which was to abandon attempts at direct control like incomes policies) coincided with the election of Thatcher, but in the US it was initiated by Paul Volcker under Jimmy Carter. In both the UK and US it was associated with attempts to control monetary aggregates, but this lasted only a few years. You could argue that abandoning incomes policies was neoliberal, but to me it looks like the inevitable result of double digit inflation.

There was a revolution in macroeconomic theory, but I have argued elsewhere that it does not fit into the Kuhnian framework. The New Classical Counter Revolution (NCCR) did not come up with an alternative analysis of inflation: instead their concerns were more methodological. It is true that that many who promoted the NCCR also favoured neoliberalism, and you could relate reductionism to individualism (and hence neoliberalism), but I think the appeal of the NCCR owed much more to a collection of good ideas that the then mainstream resisted, like rational expectations.

Inflation targeting by central banks involves an attempt to manage the economy in much the same way as Keynesian fiscal activism had done before. The central bank is a part of the state. Central bank independence didn’t come to the UK until 1997, and existed in the US well before Reagan. What I call the Consensus Assignment (monetary to demand management, fiscal to debt control) was dealt a fatal blow by the GFC, but the popularity of this assignment owes little to neoliberalism. Attempts to link inflation targeting to neoliberalism, which are frequent, are in my view a mistake.

Trying to fit macroeconomics into an account of the rise of neoliberalism is therefore problematic, and more importantly it detracts from the real economic policy revolution that neoliberalism represented, which was a change in the attitude of policymakers to state intervention of almost any kind. Out went government partnership with industry (described as ‘picking winners’), together with a regional and industrial policy serious enough to counteract the effects of globalisation and technical change. There was a corresponding shift from the collective (including attacking trade unions) to the individual, together with the idea that ‘wealth creators’ (aka high earners) had to be incentivised by cutting ‘punitive’ taxation. Public money became ‘taxpayers money’ and so on.

All this was a successful neoliberal revolution, where by success I mean it took hold for decades. It, together with subsequent overreach, has caused serious problems and is therefore ripe for review. But ironically the attempt at a truly neoliberal macro policy - hands-off monetary targeting with no demand management - failed within a few years of being tried.

[1] I should say why I think the conclusions do not follow from the rest of the paper. There are some simple mistakes, such as “the failure of these same models to predict accurately the effects of the UK vote to leave the EU threatens to renew the crisis of confidence in economic theory.” But there is also an implicit very misleading equation pair: neoliberal policy=mainstream economics, revolution=heterodoxy.

First, the two previous revolutions in macro theory came from within the mainstream, not from outside. Second, neither austerity or Brexit have anything to do with mainstream economics. More generally, mainstream economics is as much a critique of neoliberalism as a support. As a result, a revolution in economic policy making could quite easily originate from within mainstream economics (see here, for example).

[2] Today, that view has been revived by members of the MMT school, who call using the Phillips curve to control inflation amoral.


  1. I think I heard the IFS this morning predict job losses if the public sector pay cap is lifted by the Tory government.

    This could turn out to be their CBI on the minimum wage moment.

  2. "There was a corresponding shift from the collective (including attacking trade unions) to the individual"
    I'm not sure this is an accurate description. While it does describe how the policy was sold, it looks to me it was a move from collectives of human (or human capital such as trade unions) to collectives of finance capital (corporations/ financial institutions). I might be using human capital incorrectly here, opps if that is the case.

    1. I agree - I didn't like it after I wrote it but couldn't easily see how to change it. Thinking about it now, I should have talked more about the role of the market.

  3. I've gone through the 1st 20 pages of the report.
    The story so far:-
    Problem: not everything is wonderful for everyone everywhere (sad face).
    Answer: why not make everything lovely for everyone everywhere? - Smiley face!
    Let's see if the remaining 100 pages can solve that little conundrum.

    1. First the good news:-
      The UK economy is a remarkably bounteous place where people who have never needed to think critically or apply imagination can be extremely successful, as evidenced by the IPPR and its 121-page cut-and-paste report.
      The bad news:-
      People without a capacity for critical thinking (and without the imagination understand that) have been extremely successful in the UK and are in positions of influence. Evidence as before.

  4. Thanks for this and the related links: so much useful material.

    Certainly the Commission's interim work on macro-economic policy, as reproduced below,appears to need development, and some loosening of the constraints of policy-making by committee: Managed devaluation to encourage import substitution, anyone?

    That said, does the new keynesian framework as espoused by SWL, really boil down at the end of day to relying on higher unemployment to counteract rising inflation, when encountered outside the ZLB?

    (2) Reforming macroeconomic policymaking:
    Macroeconomic policymaking has been unbalanced, focussed too much on
    monetary policy and not sufficiently on the role of fiscal levers. We are therefore exploring how it can be reconfigured in the following areas:
    • Fiscal rules. We are exploring the adoption of an appropriate set of fiscal rules to enable governments to promote investment and stimulate growth where required, based on a more balanced relationship between monetary and fiscal policy
    • The Bank of England. We are examining the mandate and macroeconomic
    objectives of the Bank of England. We are looking, for example, at the case
    for targeting nominal GDP and employment as well as price stability, whether the payment system should be changed to allow for negative nominal interest rates, and the possible role of the Bank in advising on the integration of monetary and fiscal policy
    • Exchange rate policy. We are also exploring the role of macroeconomic policy in improving the cost base for UK exporters, such as through managed adjustment to the exchange rate or a system of credits to control imports industrial supply chains.

  5. Economics: the emancipation of science from politics
    Comment on Simon Wren-Lewis on ‘Revolutions in Economic Policy’

    There is the political realm and there is the scientific realm. Roughly speaking, the issue in the political realm is about the realization of the Good Society and the issue in the scientific realm is to gain knowledge about how the universe or one of its numerous sub-domains works. Knowledge takes the form of a theory that fits the criteria of material and formal consistency. The true theory is the humanly best mental representation of reality.

    In politics, open questions are decided by the legitimate sovereign, in science they are decided by proof/disproof. Scientific standards are well-defined: “Research is in fact a continuous discussion of the consistency of theories: formal consistency insofar as the discussion relates to the logical cohesion of what is asserted in joint theories; material consistency insofar as the agreement of observations with theories is concerned.” (Klant)

    There is political economics and theoretical economics. The main differences are: (i) The goal of political economics is to successfully push an agenda, the goal of theoretical economics is to successfully explain how the actual economy works. (ii) In political economics anything goes; in theoretical economics, the scientific standards of material and formal consistency are observed.

    Political economics has produced NOTHING of scientific value in the past 200+ years. The four main approaches ― Walrasianism, Keynesianism, Marxianism, Austrianism ― are mutually contradictory, axiomatically false, materially/formally inconsistent, and all got profit wrong. The pluralism of false theories is the characteristic of what Feynman called cargo cult science.

    The lack of the true theory has grave consequences: since Adam Smith, economic policy guidance has NO sound scientific foundation. The general public always sees and discusses the policy proposals of economists but never the underlying theory, therefore it fails to see that there is a total disconnect between the two. The economists’ proposals do not follow from a valid theory because there is none.

    Thomas Kuhn’s The Structure of Scientific Revolutions refers to science and by no stretch of the imagination to economic policy. A political revolution is something quite different from a scientific revolution. A scientific revolution, i.e. a paradigm shift, is caused by a failure of the current paradigm and not by a political upheaval or because of populist pressure. Scientific laws do not change when POTUSes come and go.

    In economics, a paradigm shift is urgently needed because economic theory in its four incarnations ― Walrasianism, Keynesianism, Marxianism, Austrianism ― is provably false, that is, materially and formally inconsistent.

    Economists do not understand until this day how the profit- and price mechanism works. Economics has no truth value, only some political use value. The economist is NOT appreciated as scientist, only as useful idiot.

    A Scientific Revolution in economics means that theoretical economics (= science) emancipates itself from the corrupting grip of politics (= agenda pushing).

    Egmont Kakarot-Handtke

  6. "As a result, a revolution in economic policy making could quite easily originate from within mainstream economics"

    Do you really think people who have been ploughing through Sargent over the last three years can really come up with fresh ideas for a revolution in economic policy making?

    1. As I tried to say in this post, you need to stop focusing on macro. Microeconomists do not read Sargent.

  7. Of course Michael Kalecki also predicted the problem of stagflation and the "revolution" in economic theory that it was likely to engender in "Political Aspects of Full Employment". Mark Blythe has an excellent Youtube explanation for those who search his name, Kalecki and Keynes.

  8. I agree with a lot of what you say, but In my mind current Economics graduates do not have the breadth of skills nor depth of knowledge to bring on a revolution in economics. Basically economists will have to learn to understand and accept the limitations of mathematical modelling - which the linked article identifies but does not really fully elaborate on. This will be difficult for economists to swallow for identity reasons: economists identify themselves with these models. And they conflate modelling with science. But really the interesting stuff in economics is what cannot be modelled.

    Revolution will have to come from outside. Most of all you would need people literate in philosophy - and who could work like historians. You have to know how to deal with ambiguity and logical contradiction. Much of philosophical debate, incidentally is about methodology in the social sciences: it revolves around the usefulness of positivism (basically in plain words, what can be achieved with mathematical models and rational choice frameworks).

    While I agree economic theory itself was not directly responsible for the ascent of neo-liberalism, its micro-foundations and basic starting points (absent frictions that arbitrarily throw a spanner in the works) are very consistent with what it asserts, and more than this, its very banality allowed neo-liberalism in policy making to flourish.

    Essentially what you are going to have to do is rip up everything, at least starting with everything from Paul Samuelson. You cannot reconcile such foundations and really start to look at what a social system like a national economy really is.


    1. I disagree with all of this. But in particular, why is showing all the conditions you need to make a market based system welfare maximising consistent with neoliberalism?

    2. As I have said on your blog, basing a macro-economic edifice on microfounded assumptions can never be more valid than those foundations. If micro-foundations assume profit-maximising behaviour then it is not surprising that macro models and policy prescriptions will favour the maximisation of profits. Perhaps more importantly, if distributional issues are pushed aside, as being too complicated 'for now' then we can expect 'rational' policies to ignore distribution and, in effect, reinforce existing inequalities (especially if existing inequalities reflect economic power). This all seems to me very consistent with what I understand NK to be saying.

    3. Simon, you might disagree with all of that post above, but I think you'll find that a majority of scholars in other social sciences--who are not stupid, who are well read, and probably know a hell of a lot more about the real world than average economists--would agree. Should you wish to stay in your ivory tower, that is your choice. Enough people here have been inviting you to come out of it.

    4. Are you saying that 'the majority of scholars in other social sciences' say that economists should 'rip up everything'? I'd like to see some evidence for that. As far as ivory towers are concerned, I think you have it the wrong way around.

  9. I don't know anything about neoliberal politics. Ditto micro and methodology. But we most definitely do need a revolution in macroeconomic policy, in the thinking behind it, and in the assumptions underlying that thinking.

    A policy change from low interest rates to high (or the reverse) is not a revolution. A change from raising rates to lowering them (or the reverse) is not a revolution. An increase (or the reverse) in a central bank's "reaction function" is not a revolution. And a change from cutting taxes to raising them (or the reverse) is not a revolution.

    It would be a revolution if policymakers were to stop using monetary policy to control inflation, and use tax policy for that purpose instead. That would be a revolution. I know, because people find such a change inconceivable.

    "Consensus Assignment" is a useful concept.

    1. George Bush justified his tax cuts in 2001/2 by saying the economy needed a boost. I agree the Consensus Assignment is, well, a consensus among macroeconomists, but as I say the ZLB has dealt it a fatal blow.


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